Sole Trader: How Tax Works
As a sole trader, your business profits are treated as your personal income. You pay Income Tax and National Insurance on your profits directly. There is no separate company structure between you and the earnings.
Income Tax rates (England and Wales, 2024/25)
- Personal Allowance: first £12,570, 0% tax
- Basic rate: £12,571 to £50,270, 20% tax
- Higher rate: £50,271 to £125,140, 40% tax
- Additional rate: above £125,140, 45% tax
National Insurance for sole traders
- Class 2 NI was abolished from April 2024. Sole traders no longer pay the flat-rate Class 2 NI contribution (previously £3.45 per week). This is a welcome simplification.
- Class 4 NI remains: 6% on profits between £12,570 and £50,270, and 2% on profits above £50,270 (2024/25 rates).
So for a sole trader with £40,000 net profit:
- Income Tax: 20% on £27,430 (£40,000 minus personal allowance £12,570) = £5,486
- Class 4 NI: 6% on £27,430 = £1,646
- Total tax: approximately £7,132
- Take-home: approximately £32,868
The sole trader structure is administratively simple. One Self Assessment tax return per year covers everything. There's no Companies House filing, no corporation tax return, and no formal payroll structure required.
Limited Company: How Tax Works
A limited company is a separate legal entity. The company pays Corporation Tax on its profits, and you then extract money from the company: most commonly through a combination of salary and dividends. This two-stage extraction is where the potential tax saving arises.
Corporation Tax rates (2024/25)
- Small profits rate: 19% on profits up to £50,000
- Marginal rate: 19%–25% on profits between £50,000 and £250,000 (tapering)
- Main rate: 25% on profits above £250,000
For most trade businesses, profits will fall in the 19% or marginal rate band. Corporation Tax will be 19% to 25% on the company's taxable profits.
The salary/dividend strategy
Most limited company trade business owners use the following approach to extract money tax-efficiently:
- Pay themselves a salary equal to the personal allowance (£12,570 per year) or just above the NI secondary threshold to preserve NI record. At £12,570 there is no Income Tax and no employee NI. Employer NI is minimal.
- Extract additional profits as dividends. Dividends are paid from post-Corporation Tax profits and taxed at dividend rates: 0% within the dividend allowance (£500 in 2024/25), 8.75% for basic rate taxpayers, and 33.75% for higher rate taxpayers.
This strategy works because dividend tax rates (8.75% basic rate) are significantly lower than equivalent Income Tax and NI on salary income (20% tax + 8% employee NI + 13.8%→15% employer NI).
At What Profit Level Does Incorporation Save Tax?
The tax saving from operating as a limited company rather than a sole trader generally becomes meaningful at net profits in the range of roughly £35,000 to £45,000 and above. Below this level, the accountancy and Companies House administration costs often outweigh any tax benefit. The exact crossover depends on your specific circumstances: always model it with an accountant for your situation.
Illustrative comparison at £50,000 net profit
These figures are approximate and illustrative, based on 2024/25 rates. They assume all profits are extracted as salary/dividends and do not account for accountancy costs or other variables.
Sole trader at £50,000 profit:
- Income Tax: 20% on £37,430 (basic rate band after personal allowance) = £7,486
- Class 4 NI: 6% on £37,430 = £2,246
- Total tax: approximately £9,732
- Take-home: approximately £40,268
Limited company at £50,000 profit (salary £12,570, dividends from remaining profit after Corporation Tax):
- Company pays salary of £12,570 (no Income Tax, no employee NI, modest employer NI)
- Remaining £37,430 subject to Corporation Tax at 19% = £7,112 Corporation Tax
- Post-tax profit available for dividends: approximately £30,318
- Dividend tax: 8.75% on dividends above £500 allowance ≈ £2,607
- Total tax: approximately £9,719 (Corporation Tax + dividend tax)
- Take-home: approximately £40,281
At £50,000, the saving from incorporation is modest: roughly equivalent. The saving grows meaningfully as profits increase further into the higher rate Income Tax band, where the dividend rate advantage is larger. At £70,000–£80,000 net profit, incorporation savings can run to several thousand pounds per year.
Worth remembering that the bigger lever than your company structure is usually the revenue that actually lands. Every enquiry answered fast is a job won, and every invoice chased is profit that would otherwise sit unpaid. That is the work of an office team, and Tradehand gives you one without hiring anyone: it replies to enquiries within the minute day or night and chases every invoice the day it is due, lifting the profit these tax sums are calculated on. Our guide on managing cash flow goes deeper.
Remember to factor in the costs of a limited company
- Accountancy: a good small business accountant typically charges £1,000–£2,500 per year for a limited company vs £300–£800 for a sole trader
- Companies House: £13 per year confirmation statement
- Time cost: more complex record-keeping, statutory filings, separate business bank account requirements
Liability Protection: The Other Major Difference
Tax is not the only reason trade business owners incorporate. Limited liability protection is equally, or sometimes more, important.
Sole trader
As a sole trader, you and your business are legally the same entity. If your business incurs debts or a customer successfully sues for damages and your insurance doesn't cover the full claim, your personal assets (savings, home equity, car) are at risk.
Limited company
A limited company is a separate legal entity. In the event of a claim or debt, liability is generally limited to the company's assets. Your personal assets are protected (subject to exceptions for personal guarantees, negligence by directors, or wrongful trading).
For trade businesses with significant public liability exposure: large-scale electrical installations, complex plumbing on major properties, gas work where errors could have serious consequences. The liability protection of a limited company is a genuine practical benefit alongside any tax consideration.
Good trade insurance (public liability, professional indemnity, employer's liability if you have staff) is essential whether you're a sole trader or limited company. But insurance has limits and exclusions, and a limited company structure provides an additional layer of legal separation.
When Each Structure Makes Sense
There's no universally correct answer. The right structure depends on your current profit level, growth plans, customer mix, and appetite for admin.
Sole trader makes sense when:
- Net profits are below approximately £35,000. The admin costs of incorporation outweigh the tax benefit.
- You're starting out and want simplicity while you build up the business.
- You work primarily for domestic customers and don't need the credibility of a "Ltd" company name (though this varies by sector: domestic electricians typically operate successfully as sole traders).
- You want minimal paperwork and are comfortable handling a single Self Assessment return each year.
Limited company makes sense when:
- Net profits are consistently above £40,000–£50,000 and heading higher. The tax saving becomes material.
- You work for larger commercial clients who prefer contracting with a limited company.
- You want to retain profits in the company for future investment (you can leave post-Corporation Tax profits in the company and pay dividends later, managing your personal tax rate across years).
- You have significant liability concerns given the nature of the work.
- You are growing and plan to employ staff. Employment is often tidier within a company structure.
Transitioning from sole trader to limited company
Many trade business owners start as sole traders and incorporate once their profits reach the level where it makes sense. Transition is straightforward but requires closing the sole trader, registering a company at Companies House, opening a business bank account for the company, and updating HMRC registrations. Your accountant can handle most of this process.
Getting the Right Advice
The difference between sole trader and limited company taxation involves enough variables: dividend allowance changes, Corporation Tax rates, personal allowance, your other income sources, pension contributions, spouse income sharing. That a one-size-fits-all answer is not reliable.
Before making the decision to incorporate:
- Get a modelled comparison from an accountant: a good accountant will run the numbers for your specific profit level, taking into account all relevant factors. Many accountants will do this comparison as part of an initial consultation, sometimes free of charge.
- Ask about pension contributions: making employer pension contributions through a limited company can significantly increase the tax efficiency of the company structure. This is often overlooked in basic comparisons.
- Consider your trajectory, if your profits are £38,000 now and growing steadily, it may be worth incorporating now rather than waiting until the saving is already substantial.
- Don't incorporate based on a single blog post or forum thread: the numbers change with every Budget and the right answer for one tradesperson may be wrong for another.
